Chapter 1 1

CHAPTER 1
INTRODUCTION TO ECONOMICS
INTRODUCTION TO ECONOMICS

CHAPTER OUTCOME:

Student be able to:

1. Define economics.
2. Differentiate between microeconomics and macroeconomics.
3. Define economic resources
4. Explain 3 economic concepts
5. Discuss production possibilities curve (PPC)
6. Explain 4 basic economic problems.

1.0 INTRODUCTION

What is the benefit of studying economics?

Economics concept is part of everybody life. Every action or decision may involve
economics. It helps us to make better decision-makings. Business people must have a
good understanding on the operation of the economic system to formulate good
business strategies.

1.1 DEFINITIONS

1. Some economics definitions;

a. McConnel; - the social science concerned with the efficient use of limited or
scarce resources to achieve maximum satisfaction of human material wants.
b. Economics is therefore a study of how men make use of these limited
resources to fulfill their material or worldly needs.
2. Macroeconomics:
a. concerned with the economy as a whole or with the basic subdivisions or
aggregates that make up the economy. We look at the total output, total employment,
total income, aggregate expenditures, and general price level.
b. is a bigger scope of economic activities in the economy. It is a branch of
economic analysis that involves the overall performance of the economy.
3. Microeconomics:
a. concerned with specific economic units and a detailed consideration of the
behavior of these individual units. We measure the price of specific product, income of
particular firm or household, workers employed by a specific firm and so on.
b. is a smaller scope of economic activities in the economy. It is a branch of
economic analysis that concentrates on the choice made by individual participant in the
economy.
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4. Economic resources - all the natural, human and manufactured resources that go
into the production of goods and services.

Economic resources (Factor of productions)

4 Categories

i. Land – all gift of nature that is useable in productive process such as land,
forests, mineral and oil deposit, and water.

ii. Capital – human made tools to be used in the production process. All the
manufactured aids (tools, equipment, machinery) to production used to
produce goods and services. (Money is not capital, it is only a tool to get all
those capital).

iii. Labor – all human physical and mental talents (excluding special talents -
entrepreneurial ability) that can be used in producing goods and services.

iv. Entrepreneurial ability – there is special human resources, which uses land
labor and capital to produce a goods and services. The entrepreneurs make
decision, innovate, and bear risk.

1.2 ECONOMIC CONCEPTS

The three (3) basic economic concepts are:

1. scarcity
2. choice and
3. Opportunity costs

1. Scarcity

By definition, scarcity is the situation in which human wants are always greater than
available supply of resources.
Goods and services are limited because resources require to produce are limited
compare to vast (big) human wants.

Law of Scarcity – Goods are scarce because there are not enough resources to produce
all the goods that people want to consume.

2. Choices

Choice is to choose among alternatives by comparing the costs and benefits of each
alternatives.
To choose one alternative is to give up another. We cannot have it all.
Choice involves a rational decision to be made due to scarce resources in order to
satisfy unlimited human wants.

3. Opportunity cost

The opportunity cost is what you give up in order to gain something else. It is the next
best alternative forgone.
Something we must sacrifice, or forego, in order to get something else.
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Example.
We have two choices to make, attend class or go to soccer game. The opportunity cost
of attending a class is we have to miss the soccer game and vice verse.

The concept of scarcity, choices and the opportunity costs will be clearly explained by
Production possibilities model that we will discuss in the next topic.

1.3 PRODUCTION POSSIBILITIES MODEL

The Production possibilities model shows the various possible combinations of goods
and services produces within a specified time period with all its resources fully and
efficiently employed.

1. DEFINITION

PPC (Production Possibility Curve) – is a curve which shows the various maximum
combinations of output or services that the economy can produce given a limited amount
of resources and at certain level of technology.

2. ASSUMPTIONS

In constructing this model we must assume four factors, they are;

1. Full employment and productive efficiency

- all its available resources are fully used and producing goods and services at
minimum cost .

2. Fixed resources
- the available supplies of the factors of production are fixed in both quantity and
quality.

3. Fixed technology
- the methods used to produce output does not change during analysis.

4. Two goods
- the economy is producing only two goods

Table 1.1, Production possibilities table of rice and computers with full employment and
productive efficiency.

Production Rice Computers

alternatives (hundred thousand units) (thousand units)
A 0 8
B 1 6
C 2 4
D 3 2
E 4 0
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Graph 1.1 shown graphically

Quantity of
Computers (,000)

8 A

6 B
W Unattainable due to
5
scarcity or limited resources
4 C
Z
3
Attainable Attainable and production
2  D efficiency
but inefficient
1
E
Quantity of Rice

0 1 2 3 4 5 6 7 8 9 (00,000)

3. THE PRODUCTION POSSIBILITIES CURVE (PPC)

Each point on the production possibilities curve represents some maximum combination
of two products, which can be produced if full employment and full production are
achieved.

a. Combinations on the curve (points A, B, C, D, and E)

Represent the most efficient combinations and these combinations can be
produced (attainable) using our limited resources.
These combinations explain the concept of choice. We have to make a choice
among various possible combinations of 2 goods to give more satisfaction.
And these combinations also explain the concept of opportunity cost. We cannot
increase both outputs at the same time. If we want to have more of a good, we have
to sacrifice the other good. If we want more computers means we must get less rice.
The cost of producing more computers is to forgo some of rice.

b. Combination outside the curve (point W)

Represent unattainable combination (cannot be produced) because of limited
resources.
This combination explains the concept of scarcity. Limited resources and a fixed
technology make any combination of computers and rice lying outside the curve
cannot be produced.
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c. Combination inside the curve (point Z)

Represent inefficient combination but attainable (can be produced) using our
limited resources.
But this combination indicates that full employment and productive efficiency are not
being realized. We will face the problems of unemployment, waste of resources,
and inefficiency.

4. SHAPES OF PPC

Good Y Good Y

Linear PPC Concave PPC

Good X Good X

PPC is linear – PPC is concave –

1. relates to Constant Opportunity Cost . 1. relates to Increasing Opportunity
2. *Each additional unit of good X, we cost
have to sacrifice the constant unit of good 2. * Each additional unit of good X, we
Y have to forgo more and more unit of
good Y

Example:
Production Rice Computers Opportunity cost of
alternatives (hundred thousand units) (thousand units) producing rice
A 0 8
B 1 6
C 2 4
D 3 2
E 4 0

Production Rice Computers Opportunity cost of

alternatives (hundred thousand units) (thousand units) producing rice
A 0 10
B 1 9
C 2 7
D 3 4
E 4 0
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1.4 THE FOUR BASIC ECONOMIC PROBLEMS

Regardless of how decisions are made, each economy system must answer FOUR
fundamental questions: What goods and services will be produced? How much will be
produced? How to produce? For whom will they be produced?

1. What Goods and services will be produced?

Due to limited resources, all economies must make a choice. The economy or the
society should choose the type of G&S needed by the country which satisfy the needs
of the consumers due to the limited resources.

2. How much will be produced?

The economy needs to decide the amount and the quantity that need to be produced
due to the limited resources.

3. How to produce?

The economy should determine the methods and the best techniques of production in
order to maximize production and minimized cost. Whether to use labour intensive or
capital intensive.

4. For whom will goods and services be produced?

The economy should decide who gets the goods and how to distribute them to the
people. This question is also known as a distribution question.

1.5 RELATED QUESTIONS.

Part A

1. The following diagram shows the production possibilities curve of a hypothetical

country at a given time period.

Tractors
( millions per year)

A *
*D

*E

Food (millions of tons per year)

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a) Define a production possibilities curve. (2 marks)

b) Explain what these points indicate.

i) Point A
ii) Point D
iii) Point E (3 marks)

c) Why is the shape of the production possibilities curve concave from the origin?
(1 mark)

2. The diagram below shows the production possibility curve (PPC) for rice and cloth.

Rice (kg)

B
D

A C

Cloth (m)

a. Identify the points which represent:

i. scarcity - _____________________

ii. choices - ______________________

iii, inefficiency - __________________ (3 marks)

b. The concavity of the production possibility curve indicates that opportunity

cost is ________________________. (1 mark)

c. Give three (3) assumptions in constructing a production possibility curve.

(3 marks)
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Part B

1. Briefly explain the concept of scarcity, choices and opportunity cost using
appropriate examples. (10 m)

2. Define macroeconomics. Using appropriate examples, discuss the concept of

scarcity, choice and opportunity cost. (10m)

3. Explain four (4) factors of production. Give an example of each. (10m)

4. Define microeconomic. Explain four (4) basic economic problems with examples.
(10m)

5. Differentiate between microeconomics and macroeconomics. (4m)

6. Define Production Possibilities Curve (PPC). Explain the concept of scarcity,

choices and opportunity cost using the PPC. (10m)

7. Using appropriate example(s), explain four (4) basic economic problems. (10m)

8. Using relevant examples, explain the concepts of scarcity, choice and opportunity
cost. (10m)

9. Using appropriate diagram, discuss a production possibilities curve. (10 m)

10. Explain using appropriate diagrams and tables, any two (2) shapes of PPC and
its relationships with opportunity cost.